Perennial Energy Holdings (HKG:2798) Is Reinvesting At Lower Rates Of Return

If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. So while Perennial Energy Holdings (HKG:2798) has a high ROCE right now, lets see what we can decipher from how returns are changing.

Return On Capital Employed (ROCE): What Is It?

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. The formula for this calculation on Perennial Energy Holdings is:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.37 = CN¥919m ÷ (CN¥3.7b - CN¥1.2b) (Based on the trailing twelve months to June 2022).

Thus, Perennial Energy Holdings has an ROCE of 37%. That's a fantastic return and not only that, it outpaces the average of 10% earned by companies in a similar industry.

See our latest analysis for Perennial Energy Holdings

Historical performance is a great place to start when researching a stock so above you can see the gauge for Perennial Energy Holdings' ROCE against it's prior returns. If you'd like to look at how Perennial Energy Holdings has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

What Can We Tell From Perennial Energy Holdings' ROCE Trend?

On the surface, the trend of ROCE at Perennial Energy Holdings doesn't inspire confidence. Historically returns on capital were even higher at 47%, but they have dropped over the last five years. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

On a side note, Perennial Energy Holdings has done well to pay down its current liabilities to 33% of total assets. That could partly explain why the ROCE has dropped. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

The Key Takeaway

While returns have fallen for Perennial Energy Holdings in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. However, despite the promising trends, the stock has fallen 41% over the last three years, so there might be an opportunity here for astute investors. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.

Perennial Energy Holdings does have some risks, we noticed 3 warning signs (and 1 which is potentially serious) we think you should know about.

If you'd like to see other companies earning high returns, check out our free list of companies earning high returns with solid balance sheets here.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.